The Kerry Stokes empire continues to be rattled by the ghosts of the overpriced formation of Seven West Media back in 2011, constituted by the merger of Seven Network and West Australian Newspapers — which allowed Stokes to consolidate his media interests at a minimal cost to himself. We have already seen one manifestation of those ghosts — the collapse in the value of the company from $4.1 billion in 2011 to just over $1.45 billion yesterday (and $1.2 billion in January, when the share price hit an all-time low of $1.21).

Another manifestation was on display yesterday — the $1.1 billion write-downs of the value of the licence goodwill in TV, the newspaper and magazine mastheads and the value of licences, as well as other small cuts. While “non-cash”, as Seven pointed out, the fact is those asset values have helped support the company’s balance sheet and its $1 billion-plus in debt, so they have a very real “cash” value. What the impairments tell us is the company has been forced to recognise that these media assets no longer will be earning as much money to justify those high balance-sheet values. Much of this goodwill and masthead and licence values were established or bolstered back in 2011 to support the overly high valuation of the merged company of $4.1 billion.

But there is another echo of that 2011 deal that is slowly emerging to haunt Seven and Stokes, in a way that could strangle the company if not resolved. It has the potential to force Stokes into bidding for all of Seven, or failing that, preventing Seven from paying dividends — a move that would cause the share price to plunge, and all hell to break loose.

It won’t come to that, and Seven West CEO Tim Worner made it clear in his statement the company was aware of the looming problem when he said: “We’re aware of it, we’re working through it and we expect to resolve it within the year.” And there’s no reason for the deal not to be done, seeing as Stokes is on both sides of the deal and doesn’t want to damage what is still the best media asset in the country, despite yesterday’s interim loss.

Resolving the problem for Seven, Stokes and the rest of Seven’s shareholder base will require a deal that doesn’t damage the interest of the non-Stokes shareholders in Seven West Media, who have witnessed the value of their holding collapse. A deal has to be done on the convertible preference shares by April 20 next year, otherwise Seven will be blocked from paying no dividends for shareholders, including Stokes. (Convertible preference shares convert to ordinary shares or can be redeemed in cash. They also give Stokes a foot on extra shares in Seven West media on top of the 35% he already owns and makes the company takeover-proof because they can be triggered — made convertible — in the event of a takeover.) Note 20 to Seven West’s 2013-14 accounts discloses, in part:

“Unless the CPS are redeemed, repurchased or exchanged by the fifth anniversary of their date of issue, SWM may not pay dividends, return capital or otherwise distribute value to any equal or lower ranking security holders until all CPS have been redeemed, repurchased or exchanged (subject to certain limited exceptions).”

So no deal, no shareholders, no chance of making a distribution of shares to pay a dividend. The preference shares can be redeemed — but that would require Seven having access to $250 million in cash to repay its biggest shareholder, a deal that would raise the hackles of non-Stokes shareholders and require a shareholder meeting, where it would probably be voted down.

They can be redeemed by Seven by issuing shares to Seven Group Holdings, but seeing the share price has fallen so far (and the prefs have a conversion price of $6.31), there would be a severe dilution of existing shareholders. At the current price of $1.42, around 176 million Seven shares would have to be issued to Seven Group Holdings — which is 69% controlled by Stokes. That’s 17.6% of Seven West’s issued capital, and would give Seven Group close to 53% of Seven West. That might require a takeover offer, which would add more than $1 billion in debt to Seven Group Holdings, which doesn’t want any extra debt right now. Seven Group can seek an exemption from making a bid for the minorities in Seven West, but that would strike opposition. A shareholder meeting would be required, and the chances are it would be voted down. Non-Stokes shareholders would object to the loss of any premium for control in the Seven West share price.

The convertible preference shares can be exchanged, but for what? Shares and cash sounds the best option. But the same objections arise: how benefit will be passed to Seven Group and Stokes in any deal without impacting the minorities in Seven West, and rewarding them for any loss of a control premium. And they can be rolled over in a way that kicks the can down the road in terms of their redemption, or changes their terms to reduce the chances of another potential headache occurring. It’s suggested a deal will be done and announced in time for either the Seven annual results in August, or the AGM in October or November. The question of a shareholders’ meeting to approve any deal (it will be a related-party transaction) is of interest.

And finally, Seven Group Holdings will have to fess up to write-downs of its own next week and faces more pressures from the downturn in mining here and in China (especially iron ore and coal) and the weak trading conditions and outlook for Seven and broadcast TV, newspapers and magazine. The numbers could be large.

Peter Fray

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